Federal Reserve policymakers expressed concern last month that raising interest rates too soon could pour cold water on the U.S. economic recovery, and fretted over the impact of dropping "patient" from the central bank's rate guidance.
The minutes from the Fed's Jan. 27-28 policy-setting meeting, released on Wednesday, show officials grappling to square solid U.S. economic growth with the weakness in international markets as well as worrying about falling inflation expectations in the United States.
Fed officials debated the impact that stubbornly low inflation measures were having on the central bank's confidence in moving ahead with the rate hike plan, the minutes from the Federal Open Market Committee meeting showed.
The central bank is targeting June as the month to begin raising rates, Fed policymakers have indicated.
The minutes shed light on the depth of the Fed's inflation debate and highlight the desire of policymakers to keep interest rates lower for longer.
"I think it's probably much more dovish than anybody anticipated, that's for sure," said Greg Peters, senior investment officer at Prudential Fixed Income, referring to the minutes. "I think June is going to be hard for them to move, but that's not to say they won't."
In its January policy statement, the Fed gave a nod to turmoil in markets across the globe, saying it would take "financial and international developments" into account. It was the first time since January 2013 that the Fed made an overt reference to overseas economic events in its policy statement.
The minutes offered a more detailed view of the overseas concerns, with policymakers noting how China's economic slowdown and tensions in the Middle East and Ukraine posed downside risks to the U.S. economic growth outlook.
The "international" reference in January led bond investors to quickly bet that the Fed would wait longer to raise rates, but bond yields have shot higher since early February. The surge showed that investors were getting more comfortable with the expectation that the Fed's initial rate hike would happen in June, on the back of strong economic growth and jobs data.
The release of the minutes, however, tempered that view, as bond yields fell after the 2 p.m. EST (1900 GMT) release.
"Clearly there are some more dovish members that feel the economy is still not strong enough to support steady pricing, so that is holding the Fed back from normalizing policy," said Alan Gayle, senior investment strategist at Ridgeworth Investments.
CONFLICTING SIGNALS
Even though Fed officials agreed that U.S. economic growth was strengthening, the minutes showed the central bank continuing to struggle with whether it can move ahead with raising rates amid falling inflation expectations.
"Several participants saw the continuing weakness of core inflation measures as a concern," the minutes said, detailing the Fed's internal debate over the conflicting signals sent by different measures of inflation expectations.
Though policymakers expect the recent bout of low U.S. inflation to prove transitory, they also said the different measures of expectations "needed to be monitored closely" for signs the public or investors are losing faith in the Fed's ability to reach its 2 percent inflation target.
Fed officials have said they could being raising rates even if inflation remains stuck at a low level, confident that economic growth and job gains will eventually produce rising prices. They also view the initial "lift-off" as the start of an extended, years-long process in which rates will remain far below normal and continue to boost investment and spending.
How to communicate when the Fed is ready to hike is another matter its policymakers continue to struggle with.
The Fed repeated in January that it would be "patient" in deciding when to raise benchmark borrowing costs from zero, where they have been since late 2008, and acknowledged a decline in certain inflation measures. Fed Chair Janet Yellen said in December that being "patient" implied the Fed would not raise rates at least for the next two meetings.
The minutes from the January policy meeting show that many of its participants feared that dropping "patient" - whenever the time comes - risks shifting market expectations of a rate hike to an "unduly narrow range of dates."
The reference to the narrow range of dates suggests the central bank is worried that when "patient" is dropped, investors will put too much weight on its meaning, and financial markets will overreact.
Fed officials maintained in the minutes released on Wednesday that a decision on when to raise rates would remain dependent on economic data, though moving too early was cause for concern.
"Many participants observed that a premature increase in rates might damp the apparent solid recovery in real activity and labor market conditions, undermining progress toward the committee's objectives," the minutes said.
The minutes also said many participants were inclined toward "keeping the federal funds rate at its effective lower bound for a longer time."
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